Archive for August 29th, 2007

Bob Lucas (Nobel laureate 1995) posed this paradox way back in 1990, Why does capital flow from poor to rich countries?

Ideally, it should flow from rich countries to poor ones as latter are capital scarce and need capital to finance its growth plans. It also works for rich as it would give more returns going by the high risk, high return framework. (provided it is deployed in positive NPV (Net Present Value) projects, which is always the case) .

He rejected the standard explanation of expropriation risk and argued that paucity of capital flows to poor countries must instead be rooted in externalities in human capital formation favoring further investment in already capital rich countries.

Their idea however is unless the developing coutries (that are poor) improve their track record of debt defaults, we are not going to see much improvement. They explain:

There is no doubt that there are many reasons why capital does not flow from rich to poor nations yet the evidence we present suggests some explanations are more relevant than others. In particular, as long as the odds of non repayment are as high as 65 percent for some low income countries, credit risk seems like a far more compelling reason for the paucity of rich-poor capital flows. The true paradox may not be that too little capital flows from the wealthy to the poor nations, but that too much capital (especially debt) is channeled to debt intolerant’ serial defaulters.

So as per them, despite a huge default history, number of poor countries still get a lot of capital inflows. Nice insight and a nice twist on the head. I had covered the topic of sovereign defaults earlier as well, but that discussed whys and hows. This paper provides an extension of the thought.

Like this:

I have posted quite a bit on this topic of inequality. It is increasingly becoming an issue with policymakers all over. Sustained growth and inequality have always been a problem with developing countries but even countries like US are reporting that inequality has been increasing.

I came across this intriguing report from ADB (thanks to SS Aiyar for providing the reference in his article which I covered here). It is titled ‘Inequality in Asia’ and the entire report is available for free download. As the full report is about 491 pages, there is a superb snaphot of the issues involved. It is a highly recommended reading.

For growth and development theorists, the main task so far was how do you design policies in a country so that there is sustainable growth and development. Numerous ideas have followed and Avinash Dixit provides a neat (full of humour; highly recommended) summary of the ideas. Raghu Rajan has two ideas (factor endowment and foreign leadership) and there is a different idea from Lant Pritchett as well (migration).

Now, some countries have grown and some have not. For latter theories continue (like for Africa), but for former inequality has become a big concern (like for India and China). The growth theorists have been thinking about this issue as well but with it increasing overtime more ideas would be needed to address the issue. Infact, the paper quotes Arthur Lewis, the nobel laureate suggesting growth is largely inegalitarian in nature. This aspect was well accepted by growth theorists.

This report provides a lot of food for thought on the topic and discusses basics like what is inequality, how do we measure it, causes, how Asian countries have fared and finally the measures to reduce the inequality.

I have just read the snapshot and it alone set me thinking. Some broad ideas:

It is important the way one measures it. Whether you measure by Absolute inequality (say difference in income levels between top 20% and bottom 20%) or relative inequality (share of top 20% and bottom 20% in total income), the results are different.

Income levels alone are not enough. India and Pakistan may not have very high inequality compared to others when one looks at income/expenditure levels but when one looks at social indicators like underweight children, both countries show high inequality between rich and poor.

Income inequality has been rising in most Asian Nations over last 10 years

Inequality is not about rich getting richer and poor getting poorer but rich getting richer faster than the poor.

In China the inequality has increased between urban centres as well. So, it is not just rural urban gap but urban-urban gap as well.

Causes for increasing inequality are slow growth of agriculture, differences in skill-sets (as markets have expanded and liberalised, those with skills have managed to capture most of the available opportunities)

To reduce inequality, apart from usual stuff like creating employment opportunities, expanding skill-sets, one has to distinguish between inequality arising from efforts and circumstances. It is latter which must be addressed. Basically, a born poor should get opportunities similar to born rich to reduce inequality. Well said.

It is an excellent initiative from ADB with number of ideas. Once again, it is highly recommended.

2. The debate has always been there – Whether aid works or not? It has recently hotted up after this Arvind Subramanian article which says Aid has not been effective. Rodrik comments saying it is not whether aid works or not. What matters is how you can make it more effective. There are numerous instances of aid working and not working. So make it work.

3. ET has some good articles today-
a) Prithvi Haldea says we should not allow firms to list abroad. We should first develop our own capital markets by letting companies intermediate doemstic household savings via the market route and then go abroad. He says we may be talking of developed financial markets in India but reality is opposite. This article should raise some debate in India.
b) SS Aiyar shares his views on inequality.
c) Madan Sabnavis has an interesting article on huge credit growth in India.

4. BS has a nice debate on the hot topic- Should credit raters be rated? Any crisis, credit rating agencies are held at fault. Hightime something is done about them.

5. As we debate on the efficacy of entry load charged by Mutual Funds, MFs are tinkering with their exit loads.